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Calm After the Storm

Bank Lending: More Demand, Tighter Standards

Commodities Post 3rd Worst July Ever

Rieger Report: Puerto Rico's Weight on the Muni Market

The Consequences of Concentration: 5 - Genuine Skill?

Calm After the Storm

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Fei Mei Chan

Director, Index Investment Strategy

S&P Dow Jones Indices

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The dispersion-correlation map helps us to understand the dynamics of market volatility better. Last month we observed high levels of correlation in markets across the globe following the unexpected results of the Brexit referendum.

High correlation levels can be a reflection of market fragility. However, as current dispersion and correlation levels indicate, the heightened readings at the end of June resolved in a benign way.

S&P 500 dispersion is currently sitting near the lowest levels seen in 25 years. Correlation is also below average. In remarkable contrast to June 30th  readings, both dispersion and correlation have declined sharply for the S&P Europe 350. Dispersion, notably, is below average while correlation is not much above average. In Asia, the narrative is similar.

calm after the storm

There’s no telling which direction dispersion and correlation levels are headed but one definite implication of current low dispersion levels is that the market environment for active managers to add (or subtract) value is constrained.

The posts on this blog are opinions, not advice. Please read our Disclaimers.

Bank Lending: More Demand, Tighter Standards

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David Blitzer

Managing Director and Chairman of the Index Committee

S&P Dow Jones Indices

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Three times a year the Federal Reserve surveys bank lending officers about credit standards, loan pricing and the demand for borrowing.  The Survey provides insights into business and consumer borrowing as well as where the economy may be headed.  The results of the July 2016 survey, released today, echo the details in last week’s GDP report: consumers are spending money and helping the economy while business is not rushing to invest.

The first set of charts summarizes the Survey findings about Commercial & Industrial (C&I) loans, the principal part of bank lending to business.  The Survey measures results by the net percentage of banks reporting stricter credit standards, larger pricing spreads or increased loan demand. The C&I picture reveals a slight tightening of credit standards (top panel). The data show a small decrease in the pricing spread, the difference between the interest rates charged by the bank and the rate it pays for funds. Loan demand in the bottom panel shows a very small portion of banks reported increased loan demand compared to a net decline in the previous survey earlier in the year.

Bank lending in the residential mortgage market has been active.  The second set of charts shows changes in lending standards and loan demand for mortgages. Both these areas have been volatile and in both the housing boom and bust are easy to spot. Since the beginning of 2015, banks have been easing mortgage lending standards across all mortgage types except sub-prime.  For bankers, this may be the lesson of the financial crisis; for borrowers the lesson hasn’t been fully learned. The lower right hand chart shows that demand for sub-prime loans follows the other categories closely.  Some banks reported that they do not make sub-prime mortgage loans.

Another section of the report compares current credit standards to the average since 2005. Sub-prime borrowers seeking mortgages, auto loans or credit cards will find that standards are tighter today than typical since 2005; prime borrowers will find current standards are close to the average since 2005.

The charts are from the Federal Reserve July 2016 Senior Loan Officer Survey.

The posts on this blog are opinions, not advice. Please read our Disclaimers.

Commodities Post 3rd Worst July Ever

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Jodie Gunzberg

Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

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July was a bloodbath for commodities in the Dow Jones Commodity Index (DJCI) losing 6.0% and in the S&P GSCI losing 9.6% in total return. Although the equally weighted DJCI is still up 7.4% YTD through July 29, 2016, the S&P GSCI that is world-production weighted gave up all its gains from Q2 and is now negative 65 basis points for the year, allowing stock performance in 2016 to overtake commodities for the first time since April.

Source: S&P Dow Jones Indices.
Source: S&P Dow Jones Indices.

For the S&P GSCI with history going back to 1970, this is the 3rd worst July on record, only after July in 2008 and 2015 when the index lost 12.2% and 14.1%, respectively. This is also the first time ever there have been 3 consecutive negative July’s (July 2014 lost 5.3%.) It is pretty unusual to even see two consecutive negative July’s (1976-77, 1984-85 and 1992-93) given it is mostly a seasonally positive month, posting gains about 2/3 of the time.

Source: S&P Dow Jones Indices.
Source: S&P Dow Jones Indices.

In total, 16 of 24 commodities lost in July, which is the most since November’s Nightmare in 2015 when 22 were down. The month’s performance was highly segmented by sector with major losses from energy (-13.6%,) agriculture (-6.5%) and livestock (-7.4%.) Brent crude and (WTI) crude oil each declined notably -13.5% and -15.3%, respectively, in their 2nd worst July and 13th worst month ever on declining Chinese demand and rising supplies. Further, lean hogs posted its 4th worst month on record, -17.5%, and its biggest loss since Aug. 2002. Also, gasoil posted its 6 worst month on record, -16.8%, only the worst since Dec. 2015, but its worst July ever.  All the single commodities in these sectors lost except cocoa +0.4% and cotton, the best performer of all, gained 15.4% from plunging inventories due to drought.  This is cotton’s 13th best month and fifth consecutive positive month, driving its longest winning streak since Nov. 2013 – Mar. 2014.

However, cocoa and cotton weren’t the only bright spots in commodities in July. Both industrial and precious metals performed well, gaining 2.0% and 3.1% for the month in the S&P GSCI, respectively.  Aluminum was the only loser, down slightly, shaving off 79 basis points from oversupplied markets and excess capacity.  Nickel gained 12.4%, the most of any metal in the month on stainless steel production, though zinc’s gain of 6.5% brings its 2016 performance up to an impressive 38.5%, surpassing gold’s 2016 gain of 27.1%.

While gold held onto its record gain post Brexit vote, silver showed its sensitivity, adding 9.3% in July more than quadruple gold’s monthly gain of 2.3%.  This may indicate real fear hasn’t gripped investors into holding gold instead of silver yet and that they are willing to take some economic risk from industrial applications of silver.  On average when gold rises, silver rises about 2.7 times as much, but when gold falls, silver falls about twice as much.  Though in crisis times, gold often gains while silver falls. This last happened in Aug. 2015 around the Chinese stock market volatility, but also occurred in the global financial crisis, tech bubble burst, Black Monday and the early 80’s recession.

Last, one more potentially positive note is that nine commodities are showing positive roll returns, measuring shortages. This is happening in corn, cotton, feeder cattle, lean hogs, live cattle, natural gas, soybeans, sugar and wheat, It is the most since Mar. 2015 when 11 commodities were in this condition, and is particularly rare for natural gas which hasn’t seen a positive roll in 18 months.  Overall, it is a complete turn around from the commodity conundrum experienced in April despite the record positive performance just 3 months ago.

Our 10th Annual Commodities Seminar takes place in London on 29th September. Additional information and registration are available online now. #SPDJICommods

The posts on this blog are opinions, not advice. Please read our Disclaimers.

Rieger Report: Puerto Rico's Weight on the Muni Market

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J.R. Rieger

Head of Fixed Income Indices

S&P Dow Jones Indices

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Puerto Rico remains a puzzle unsolved.  The large amount of Puerto Rico debt continues to weigh on the municipal bond market with the heaviest exposure in the high yield (below investment grade) segment.  Puerto Rico municipal bonds have over 27.1% market value weight in the S&P Municipal Bond High Yield Index and represent over $26.7billion in market value of bonds in that benchmark.

The broadest municipal bond index S&P publishes, the S&P Municipal Bond Index ,  tracks over $1.7trillion in market value of municipal bonds.  The sum of all Puerto Rico bonds in that index represents 1.77% of the total market value of the index.  This total includes bonds that are in default, insured, prerefunded as well as bonds that are escrowed to maturity.

The S&P National AMT-Free Municipal Bond Index is an investment grade index that excludes Puerto Rico bonds as well as bonds from other U.S. Territories. There is no Puerto Rico exposure in that index.

There are $9.7billion in market value of insured Puerto Rico bonds that are tracked in the S&P Municipal Bond Insured Index .  The insured Puerto Rico bonds represent slightly over 5.5% of the total market value of that index.

Table 1) Select S&P municipal bond indices and the percentage of Puerto Rico bonds by market value in each index

Source: S&P Dow Jones Indices, LLC. Data as of July 29, 2016. Table is provided for illustrative purposes. It is not possible to invest directly in an index. Past performance is no guarantee of future results.
Source: S&P Dow Jones Indices, LLC. Data as of July 29, 2016. Table is provided for illustrative purposes. It is not possible to invest directly in an index. Past performance is no guarantee of future results.

Please join me on Twitter @JRRieger  and LinkedIn

The posts on this blog are opinions, not advice. Please read our Disclaimers.

The Consequences of Concentration: 5 - Genuine Skill?

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Craig Lazzara

Managing Director and Global Head of Index Investment Strategy

S&P Dow Jones Indices

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Should active managers shift away from well-diversified portfolios and concentrate only on “high conviction” holdings in hope of generating higher returns?  We have suggested four consequences — higher risk, greater dominance of luck over skill, higher costs, and fewer outperforming funds — that are likely and logical outcomes of higher concentrationAll four apply even for active managers with genuine stock selection skill.  Once we consider the nature of skill, however, the case against greater concentration becomes even more compelling.

The argument for concentration relies on two assumptions: that manager skill exists, and that it is particularly acute at the extremes of conviction.  Not only, e.g., must a manager be able to build a 100-stock portfolio that will outperform, he also must be able to identify which 20 stocks of the initial 100 are the best of the best.  For concentration to work, both assumptions — that skill exists, and that it is acute at the extremes — must be true simultaneously.  There is no evidence that either of them is.  If it exists at all, the requisite skill must be quite rare.  If this were not so, active funds would not be facing a performance challenge in the first place.

On the contrary, the evidence that manager skill is ephemeral is strong:

  • The only source of excess return, or positive alpha, for the market’s winners is the negative alpha of the losers.  In aggregate, professional active management is a zero-sum game.
  • Because passive investors own a pro-rata slice of the market, their aggregate portfolio is identical to the aggregate portfolio of all active managers. But passive investment is intrinsically cheaper than active management, so that the average passively-managed dollar is arithmetically certain to outperform the average actively-managed dollar.
  • In support of these conceptual points, the empirical evidence is unequivocal.  Most active managers underperform benchmarks appropriate to their investment style, and the comparisons become more arduous as the timeframe for evaluation lengthens.  Moreover, when above-average performance occurs, there is scant evidence that it persists.

Skillful managers sometimes underperform; unskilled managers sometimes outperform.  The challenge for an asset owner is to distinguish genuine skill from good luck.  The challenge for a manager with genuine skill is to demonstrate that skill to his clients.  The challenge for a manager without genuine skill is to obscure his inadequacy.  Concentrated portfolios will make the first two tasks harder and the third easier.

The posts on this blog are opinions, not advice. Please read our Disclaimers.